Market Perspective for December 26, 2022

Stocks were mixed over the past week. While Dow Jones posted a moderate gain of 0.86 percent, the S&P 500 and Nasdaq lost 0.2 percent and 2.2 percent, respectively. Once again, tech stocks took the brunt of the losses.

This was the third straight week in which S&P 500 and Nasdaq ended in the red. The S&P 500’s performance this year is slated to be its worst year since 2008, loosing 18 percent year to date, even when accounting for dividends.

Among the sectors that lost the most in S&P 500, consumer discretionary led the list, which lost 3.1 percent last week and 36.9 percent year-to-date. Closely following it on the downside was the information tech sector losing 2 percent for the week and 28.1 percent year-to-date. Energy gained 4.4 percent for the week and is now up 64.7 percent year-to-date.

The 10-year US Treasury bond yield rose to 3.75 percent on Friday from 3.48 percent seven days ago.

Inflation has cooled since July and should slow further in 2023. The Federal Reserve isn’t declaring victory yet. At its December meeting, the Federal Reserve reiterated the need for higher rates for longer. It stressed the strong labor market, accelerating wage growth and concern about entrenched inflation. Some of the manufacturing surveys underscored this point. The Empire Manufacturing survey covering the New York Fed’s region shifted in an inflationary direction, with the number of firms predicting falling prices next year dropping to zero. The Fed’s own economic forecasts included GDP growth as low as 0.5 percent and unemployment rising to 4.6 percent, along with predicted interest rates rising to around 5.0 percent. The Federal Reserve signaled it will accept some economic slowdown in its battle to wring inflation out of the economy.

The Federal Reserve has been aggressive because economic growth remains strong and labor markets tight. The Atlanta Federal Reserve’s GDPNow model projects 2.8 percent growth for the fourth quarter, about in line with last quarter. Continuing unemployment claims have ticked up, but initial claims have moderated. Wages increased 0.6 percent in November and 5.1 percent versus the prior year. Strong labor markets are lagging indicators, but the Federal Reserve cannot risk nascent wage inflation taking hold. In Federal Reserve Chairman Powell’s December press conference, he mentioned the Fed regional business surveys. While hiring hasn’t been robust, employers are telling the Fed that they can’t find skilled workers. This indicates wage pressures could accelerate if the economy remains strong.

2022 was a rough year for the markets, but performance depended greatly on portfolio positioning. It was not a broad-based bear market that took down everything, even though there were periods where all sectors declined. On the bearish side, four sectors have 25 percent or larger losses heading into the final two weeks of trading: real estate, technology, consumer discretionary and communication services. Except for real estate, these sectors are dominated by stocks that were formerly in the technology sector or are considered tech stocks by investors, such as Amazon and Tesla in consumer discretionary.

Losses are sharply curtailed outside of growth sectors. The next-worst returns came from financials and materials, down about 12 percent each or half of the technology losses. Industrials is down about 5 percent. Consumer staples, healthcare and utilities can all finish the year with gains if the last two weeks are bullish. Energy leads with a return near 60 percent.

As we’ve discussed many times, large-cap tech stocks account for more than 40 percent of the S&P 500 Index. These stocks are responsible for the bulk of the S&P 500’s losses. Additionally, the S&P 500 Index was underweight energy, which has climbed 60 percent.

Fourth-quarter earnings season will be underway soon. With inflation coming down, recession and falling earnings are the main risks on investors’ radar. The S&P 500 Index is expected to see earnings contract by 3 percent. Energy leads with a forecasted growth rate of 64 percent. Analysts see industrials at 38 percent, real estate 10 percent and utilities 3 percent. Consumer staples, technology, healthcare and financials are all expected to see earnings contract less than 10 percent. Weighing on the index are expected dips of 18 percent, 19 percent and 24 percent in the communication services, consumer discretionary and materials sectors, respectively.

There will be a limited amount of data released this week. Home prices are scheduled to be released on Tuesday. Apart from that, Wednesday will see the report on pending home sales. The weekly unemployment data is scheduled to be released on Thursday. After that, however, the most significant report will be released by the government on January 6, which is the government’s monthly employment report.

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